News from DNB Markets

(22.07.2011)
Euro zone leaders agreed on a second rescue package for Greece yesterday, worth around 109bn. euros. In addition, private investors will contribute with an estimated 37bn. euros.

By Anders Grøn Kjelsrud, Analyst at DNB Markets

The markets received the news with relief, while rating agencies are likely to conclude with an (selective) Greek defaults – the first in the euro’s history.

The closely watched EU summit concluded with a plan, effectively consisting of three elements. Firstly, the maturities will be extended and interest rates lowered on the existing bail-out loans to Greece, Portugal and Ireland – maturities up from 7.5 years to a maximum of 30 years, interest rate down to 3.5 per cent for all three countries.

Secondly, the euro zone leaders agreed to overhault the existing emergency fund, the EFSF. From now on the fund will be able to provide financial assistance to countries who have not received official bail-out help, and to help recapitalize European banks. Furthermore, the EFSF will be allowed to buy government debt in the secondary market under "extraordinary" circumstances.

The third, and definitely the most debated point, includes private investors' participation in the bail-out package, and must be viewed as a political victory for Angela Merkel. Under the new agreement private investors are expected to contribute with around 37bn. euros, via four optional channels – three of which include debt exchange arrangements, and one rollover plan. Severe newspapers refer to an estimate of an average reduction of investors' net present value of Greek government bonds by around 20 per cent. But since the program is voluntary, the true private contribution will not be known before bondholders actually decide to take part.

In addition to the estimated 37bn., the euro zone leaders are expecting that a small-scale buy-back scheme of Greek government debt will bring in roughly 13bn. Although the private participation is referred to as "voluntary," it is likely to lead the rating agencies to the conclusion of a "selective default" – a term used for countries that fail to meet certain liabilities, while the rest of the debt obligations are handled as normal. The ECB and Jean-Claude Trichet has long argued against any action resulting in such an outcome, but after assurances that the scheme will apply to Greece only, and that the period defined as the default probably could be limited to “a few days”, Mr. Trichet softened his stand.

The question is whether all of this, which, according to Sarkozy will reduce the Greek debt burden by 24 per cent, is sufficient to lead Greece to a sustainable debt path. The answer is probably no. Although the package definitely reduces the country’s short-term payments pressure, and also reduces the overall debt burden, it is probably not enough to ensure long-term solvency. The debt level will still be considerable, forcing Greece to further harsh fiscal tightening, at a time when economic activity declines. It is worth emphasize then, that the other euro zone members now have made bold commitments to help Greece (and other member countries) until they are able to obtain funds in the financial markets on their own.

The market actors seemed to receive the news with relief. The euro gained versus most currencies in FX, and EURUSD is currently traded around 1.44, after dipping below 1.42 early in yesterday’s session. Furthermore, yields on government debt of the most indebted European countries fell fairly sharply. US and European stocks also saw solid gains, the same could be said of Asian stocks tonight.

In addition to the Greece bail-out agreement, signs of progress in the US debt talks could have boosted confidence. In any case, what is certain regarding the latter is that the negotiations are entering a critical phase, as the debt ceiling is approaching.